The recent tax changes announced in the Budget will affect discretionary trusts. M&G Wealth’s Neil Macleod looks at why and how.
After much speculation, the Autumn Budget brought no major surprises for financial planners – a welcome relief after recent tax changes. Nevertheless, the announcements around property, savings, and dividend income merit attention. These changes have implications for investment taxation and, crucially, trusts. Discretionary trusts remain popular due to the flexibility they offer however, but their tax treatment is complex. So what do the changes mean for discretionary trusts?
Discretionary Trust Income – 2025/26
From 6 April 2024, the standard rate band for discretionary trusts was abolished. All trust income is now taxed at 39.35% for dividends and 45% for other income. Trustees must file annual tax returns, pay tax, and maintain the “tax pool”.
When income is distributed, it becomes “trust income,” losing its original character. Beneficiaries cannot use allowances for dividends, savings, or property income. If trust income exceeds the personal allowance, it’s taxed at standard UK (or Scottish/Welsh) rates for non-savings income. Most beneficiaries will need to file a tax return to reclaim tax*. Trust income carries a 45% tax credit. Trustees may need to top up tax payments to ensure 45% has been paid, especially if the tax pool is insufficient (e.g. when income includes dividends).
*There are also rules where the trust is “settlor interested” and the settlor is assessed on income which remains unchanged.
Budget changes
The 2% rate increase on dividends from 6 April 2026 apply to the ordinary and higher rates only. No changes were made to the dividend trust rate of 39.35% so it’s business as usual for trustees receiving dividends ( remember, trustees may still need to pay more tax on distribution to satisfy the tax pool).
From 6 April 2027, the tax rates on savings and property income received by discretionary trusts will increase by 2%. This means the current trust rate of 45% for non-dividend income will rise to 47% where it relates to savings or property.
Interestingly, there was no change to the legislation in the Finance Bill to the tax credit when income is distributed suggesting this will remain at 45%. But what will happen if a trust receives only savings or property income, pays tax at 47% and is limited to a 45% tax credit?
Example:
A discretionary trust receives property or savings income of £1,000 in the 2027/28 tax year. They distribute this to a beneficiary (John), who is a basic rate taxpayer. Assuming no trust expenses it appears the situation would be as follows.
- Trustees will pay 47% tax i.e. £470
- £530 is distributed to John with an accompanying tax credit of £433.63
- John’s assessed on trust income of £963.63
- John must pay 20% on the trust income so his liability is £192.72.
- John can reclaim the difference between the tax credit and his liability i.e. £240.91
This results in a net return of £770.91 from £1,000 of income received by the trust, an effective rate of tax of 22.9% which is higher than the new savings basic rate. Under current rules John would suffer only 20% on this income overall, the same he would on his personal savings income. And what about the extra tax paid by the trustees? We’ll see how the Finance Bill progresses before it becomes law but on first reading it appears this may be lost.
What about investment bonds?
Historically, many trustees of discretionary trusts have used investment bonds, partly down to the high rates of tax on other types of income (which can usually be avoided when using a bond), but also the administrative simplicity they provide. Trustees can make use of the tax deferred allowance to avoid triggering chargeable gains within the trust or can assign segments to beneficiaries prior to encashment. The Budget hasn’t impacted these tax planning strategies but the taxation of bonds will change.
Chargeable Gains from Investment Bonds – 2025/26
Chargeable gains within a discretionary trust are assessed on the settlor if they are UK resident and alive at any point during the tax year of the chargeable event. The settlor must file a tax return and if any tax is due, this should be reclaimed from the trust. Gains assessed on a settlor or beneficiary can use personal and savings allowances, and top slicing relief may apply.
If the settlor is deceased or non-UK resident, gains fall on trustees at 45% (for UK resident trusts). For onshore bonds, trustees pay an extra 25% after a 20% credit. Trustees cannot claim top slicing relief, and beneficiaries receiving bond proceeds get no tax credit. For this reason trustees will often assign segments to beneficiaries before encashment to avoid the trustee rate.
For non-UK resident trusts, HMRC assess the beneficiary who receives the proceeds. In these relatively niche cases beneficiaries cannot claim top slicing relief. If the beneficiary is non-UK resident, HMRC may assess them later if they become UK resident.
Budget changes
The changes to the taxation of savings income from 6 April 2027 will result in a few changes to the taxation of bonds held in discretionary trusts.
Where the settlor or beneficiary is assessed on the gain, they will now need to pay tax at the increased savings rates where the gain exceeds their savings allowances.
- Offshore bond gains will roll up gross and gains will simply be subject to the new rates of tax.
- The internal tax rate paid by UK life funds will increase to 22% on non-dividend income. Dividends will continue to be exempt.
- If the gain arises from an onshore bond, they will receive a tax credit of 22%. Basic rate taxpayers will have no further liability. Higher rate taxpayers will pay another 20%, additional rate 25%.
- Top slicing relief will still apply to both onshore and offshore bonds. The legislation has been amended so that the “tax treated as paid” in the top slicing relief calculation will also reflect the new rates.
So, what does this all mean for adviser’s providing investment advice to trustees? As is the case now, the make-up of the underlying returns and the tax position of the beneficiaries will be key in the overall effective rate of tax being paid. However, in light of the budget changes and the increased complexity of the tax pool, a non-income producing investment such as a bond will remain an attractive investment option for trustees. Despite the increased tax internally, Onshore bonds perhaps have the edge over offshore bonds for taxpayers, due to no tax being payable on dividends internally and a tax credit to cover a basic rate beneficiary’s liability. Offshore bonds will continue to be attractive where appointing or assigning segments to beneficiaries with available savings allowances could lead to tax free returns.
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